Before you jump out into the investing world, there are two financial parachutes you need to have strapped to your back.
Have you ever skydived before? Have you ever skydived before?
From what I hear from friends who’ve done it, skydiving is an exhilarating, once-in-a-lifetime experience. They talk about the excitement and anticipation you feel when you first board the place, not knowing what to expect. However, as the place takes off and slowly rises to 5,000, 10,000 and finally 15,000 feet, that same anticipation quickly turns to fear and trepidation.
As the plane levels off, your instructor tells you it’s time to go. You gingerly approach the open door and the blood immediately drains from your face as you look at all that empty space below you. Suddenly, over the hum of the engine, you hear your instructor yell: “JUMP!” and before you know it, you’re careening 200 kilometres per hour toward the ground screaming and wondering why you paid $300 to kill yourself.
But as you freefall, you suddenly realise that you no longer feel like you’re dropping. In fact, it feels like you’re flying… floating in the air even. But before you have the time to fully get a feel for things, your instructor pulls the cord. The parachute opens up and suddenly everything becomes calmer. You glide to the earth, taking in the scenery and enjoying the view all around you.
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When you finally land, adrenaline is coursing through your veins and your face is beaming brighter than the midday sun. You tell yourself it was the best experience of your life and you can’t wait to do it all over again.
Sounds fun, right? I’m sure it is — 100%.
Now imagine jumping off that plane and freefalling to 2,000 feet. It’s now time to deploy your parachute. Your instructor pulls the cord and realises that the parachute isn’t working! Your instructor is now looking alarmed. This has never happened to him before. He pulls the cord for the reserve chute and that fails to deploy as well. He’s now in full on panic mode. Both of you have NO working parachute and will hit the ground in just 10 seconds.
What now?
What sort of emotions will you feel as you fall to your impending death knowing that both your parachutes have malfunctioned?
Shock, horror, fear. And probably the all-encompassing terror that nothing can save you when you finally hit the ground.
Your financial parachutes
We enjoy the experience of skydiving because we carry a parachute (with a reserve chute) every time we jump. We say it’s the best experience of our lives! But the moment, you lose your parachute, the once-happy experience of freefalling through the air becomes a terrifying suicide jump.
We all know you need two parachutes when you skydive. Except this bad ass who jumped 25,000 feet without one. (Legend says the reason why he fell so fast to the ground was because he had balls of steel.)
Likewise, you also need two parachutes when you invest. Why? Simply because the stock market can be extremely unpredictable and volatile, especially in the short term. If the stock market goes into freefall, the parachutes are there so you’re not forced to liquidate your stocks at the worst possible time.
What are the two parachutes must you have?
Parachute 1: Save
The first parachute you need is to have at least six months’ worth of expenses in savings. For example, if your average household expenses are $5,000 a month, then you need to save at least:
$5,000 x 6 = $30,000
This essentially means if you’re unable to work and unexpectedly lose your main source of income, you can cover your household expenses for at least the next six months while you get things back on track. (You can save up to 12 months if you’re more conservative, in that case you have a one year buffer.)
You don’t want to be caught in a situation where you need the money and you’re forced to sell your investments at a loss because you didn’t save enough for a rainy day.
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Open two bank accountsThere’s no secret to saving money: we simply need to spend less than we earn. But we can make the task easier by tracking how much we save.
If you only have one bank account, open another one. Preferably you should have one current account that’s used to issue cheques, pay your bills, and manage your daily finances. And one savings account that’s used for your… savings.